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Hilton IPO Looks Like No Bargain for Those Checking In on Day One

·Michael Santoli
An exterior shot of the Hilton Midtown in New York in this June 7, 2013, file photo. Hilton Worldwide Inc said its initial public offering would raise up to $2.37 billion (�1.45 billion) in the biggest-ever hotel IPO, more than doubling Blackstone Group LP's investment, December 2, 2013. REUTERS/Andrew Kelly/Files (UNITED STATES - Tags: BUSINESS TRAVEL SOCIETY LOGO) (REUTERS)

Blackstone Group (BX) is preparing to check out of Hilton Worldwide Holdings Inc. at a more opportune time than the private-equity shop checked in six years ago.

When Hilton’s initial stock offering is priced Wednesday evening, it will be cheerily welcomed into a market in love with hotel stocks, which have been excellent performers all year, thanks to climbing occupancy rates and room charges. Hilton shares will begin trading Thursday morning on the New York Stock Exchange, under the ticker symbol "HLT."

Investors tend to flock to lodging stocks near the mid-point of an economic recovery cycle, as incremental gains in employment and corporate spending help bestow pricing power and profit-margin leverage upon hotel operators.



As a result, Hilton shares will almost certainly debut fully valued and perhaps, after any initial pop in the stock, at an overly generous valuation as a blue-chip core holding.

Hilton which Blackstone took private in a top-of-the-market leveraged buyout in 2007 for $26 billion, including $20 billion in debt will immediately become the largest publicly traded hotel company. The formal price range for Hilton shares is $18 to $21. But the company moved the deal ahead one day in response to heavy demand already reflected in order books, which reportedly show the offering to be oversubscribed by a factor of five.

A hefty offering

At the top end of the range, the deal would raise $2.7 billion, more than Twitter Inc. (TWTR) did last month in its $1.7 billion IPO and just a bit less than the $2.8 billion Plains GP Holdings (PAGP) offered in the year’s largest initial stock sale.

Blackstone, the world’s largest private-equity player and one of the biggest real-estate investors, stands to make some $8 billion in on-paper profits once the deal is done. But that’s not because Hilton had good timing in purchasing the trophy company in 2007, a time when a huge commercial-real-estate boom was tilting to a crash and the Great Recession was about to gut travel budgets.

Yet after refinancing much of its debt, temporarily marking the investment down to 70 cents on the dollar, installing industry veteran Christopher Nassetta as CEO, and expanding its room count 36% almost entirely through franchised hotels overseas, Blackstone has Hilton well-positioned to draw public investors and capitalize on a relatively bright outlook for global lodging brands.

This is one way big private-equity firms can generate good returns – not necessarily by purchasing depressed assets using debt and fixing the companies, but by using their financing heft, riding out rough times insulated from public markets and opportunistically timing their “monetization” moment.

Blackstone itself is selling no shares in the deal, though it is fully expected to do so in the coming couple of years. It will own 750 million shares, or 76.5% of the company, following the IPO.

At the $21 upper end of the price range, Hilton will have a market value of $20.6 billion, a good deal larger than both Marriott International Inc. (MAR) and Starwood Hotels and Resorts Worldwide Inc. (HOT). The company will have some $12.5 billion in net debt, giving it a total enterprise value (market cap plus net debt) of more than $33 billion, or 27% more than the 2007 LBO purchase value.

Christopher Agnew, lodging analyst at brokerage firm MKM Partners, issued a report on Hilton ahead of the IPO that called its valuation based on its enterprise value to cash flow “broadly in line” with peers such as Mariott and Starwood, assuming the stock is priced within the range.

He points out that the hotel business is in the “sweet spot” of its cycle, when room rates begin to climb nicely, and says Hilton has the heaviest pipeline of new rooms planned or under construction, mostly overseas. Further, he says Hilton’s huge urban flagship hotels should be outsized beneficiaries of rising, late-cycle demand from corporate conventions and other “group travel” business.

Of course, most of these trends have been underway for some time, and the market has become wise to them. The Dow Jones US Hotels Index is up 335% from recession-depressed levels of five years ago, and has gained 27% year to date, roughly in line with the Standard & Poor’s 500 Index.

This implies Hilton shares will be well received by the Street, and perhaps will go smartly higher once they begin trading. It will be seen as a blue-chip, core holding in an in-favor consumer sector, and investors will pay up to own it. Yet in that case, the stock will almost certainly be stoutly valued. At $21 a share, its EV/cash flow based on expected 2013 results will be more than 14.5-times, says Agnew.

Sure, cash flow now looks to grow 8% to 9% a year for the next couple of years, but this valuation is just about at the multiple Blackstone paid, financed 75% by debt, in its aggressive, top-of-market 2007 LBO.

Hilton will have a strong ability to rapidly pay down its debt load, though of course it begins with vastly more debt than its peers. And keep in mind that Blackstone’s 750 million shares will represent a likely overhang of new selling supply over the stock for the foreseeable future.